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Today's WrapUp by Jim Puplava 02.23.2004 Mon Tue Wed Thu Fri Archive |
Helicopter Money
The world is awash in liquidity with helicopter money that is printed out of thin air and dumped on to the financial system. Central banks everywhere are injecting vast amounts of credit and money into the financial system. Fiscal and monetary policy is focused on reflating the global economy. Money is literally being dropped from helicopters on to the financial system and the economy.
The three main culprits are the Bank of Japan, the Bank of China and the Federal Reserve. Central banks are expanding their broad money aggregates with some more aggressive than others. Not since the Dutch Tulip Mania, the Mississippi Scheme and the South Sea Bubble days of the 17th century has there been this much money printing. The money aggregates are expanding everywhere and this in itself is inflationary. Inflation is an expanding money supply and everywhere you look the supply of money is growing and expanding. Governments are financing never ending deficits with limitless oceans of paper money. If the present rate of monetary expansion continues unabated, we may soon run out of forestable land. Central bankers will need to harvest all of the world’s timber just to keep up with the pace of monetary inflation.
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MONEY SUPPLY* % CHANGE ON YEAR AGO |
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| Country | Narrow | Broad |
| Australia | +8.7 | +13.7 Dec |
| Britain | +7.4 | +6.7 Dec |
| Canada | +10.0 | +6.9 Dec |
| Denmark | +8.8 | +8.8 Dec |
| Japan | +4.3 | +1.6 Jan |
| Sweden | +2.8 | +2.6 Dec |
| Switzerland | +21.0 | +7.6 Dec |
| United States | +6.3 | +3.3 Dec |
| Euro Area1 | +10.6 | +7.1 Dec |
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Source: The Economist, Feb 14, 2004 |
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*Narrow: M1 except Britain and Sweden MO, Broad: M2 or M3 except Britain M4
Not since the days of the Weimar Republic have we seen this level of monetary debasement. These are truly historical times. A grand experiment in monetary affairs is being carried out by major central bankers in an effort to create wealth and prosperity out of nothing. Paper wealth, which is really artificial wealth, is not being created through the expanded production of goods or through the building of property, plant, and equipment. Instead paper wealth is being created through unlimited money and credit that is created artificially. There is nothing backing this money other than the faith of those who accept it as payment for goods and services. It isn’t backed by gold or silver. It is just paper whose value is whatever the market says it is. There is no intrinsic value for this money because there is no substance behind it.
Twin Deficits: The Driving Force
The driving force behind this monetary expansion is the twin deficits of the U.S. The government’s budget deficit this year is estimated to run as high as $540 billion, another record. The U.S. trade and current account deficit already at record levels is expected to come in at over $500 billion this year. Despite the drop in the dollar index from 120.90 in July of 2001 to today’s 86.92, a drop of over 28% has failed to correct the huge U.S. trade imbalance. The December trade deficit was $42.5 billion. The excess of imports over exports of goods and services in December was the largest since the record $43 billion in March. The commerce Department reported that imports jumped 3 percent in December to $132.8 billion, a new monthly high. The U.S. imported more oil and paid higher prices for its thirst for energy. Oil imports rose 12 percent. In addition to importing large amounts of oil, the U.S. imported more capital goods than it exported. In other words the trade deficit is structural. Much of what we need and consume in this country is made overseas. It is going to take a much bigger decline than what has transpired in the international currency markets before there is any hope of closing America’s colossal trade gap.
The dollar fell 8 percent last year against a basket of currencies of other major trading partners. It has fallen 13 percent since early 2002. Apparently the lower dollar has done little to stem the tide of imports into this country. As the U.S. imports more oil and capital goods into this country, the trade deficit will only get larger. This means there will be more dollars sloshing around the globe and monetary expansion will continue unabated. Further, this means the inflationary spiral will continue. As along as central banks can expand money and credit at will we will continue to experience inflation, inflation being primarily a monetary phenomenon.
As long as foreigners continue to accept our paper dollars they have very few choices on what to do with those dollars. They can either convert those dollars into their own currency or invest those dollars in U.S. If they convert those dollars into their own currency their currency would appreciate sharply as a result of the size of those dollar surpluses. This would put and end to their trade surplus which could in turn drive their economies into recession. The other alternative is to invest those dollar surpluses into U.S. dollar assets fueling asset bubbles here in the U.S. in stocks, bonds, mortgages, and real estate, which is what they are now doing. The result of these trade imbalances is that dollar reserves or dollar liquidity keeps expanding at an exponential rate as shown in the graph below.
Source: Richard Duncan, "Asia, its reserves and the coming dollar crisis"
Since the breakdown of the Bretton Woods, International Monetary System total international reserves have increased by more than 2000%. They are now growing parabolically at a rate of $1 million a minute and now approximate roughly 2% of global GDP.[1]
Japan's Central Bank to the Fed's Rescue
This is clearly an unsustainable trend that will ultimately end in a dollar crisis. The Federal Reserve is trying to work its way out of a financial bubble of its own creation and it has enlisted the Japanese central bank as its surrogate. Last year alone Japan acquired $250 billion in U.S. assets, an amount equivalent to 4 percent of Japan’s GDP. Japanese monetary authorities created Y 27,000 billion. The amount of money that Japan’s central bank created out of thin air was large enough to finance 13 percent of the U.S. budget deficit. This year that amount will be even larger. This year Japan’s central bank will print enough Yen to purchase up to $575 billion of U.S. assets. Alongside of Japan, China, which is running a trade surplus of $125 billion with the U.S. each year, has allocated up to $150 billion. At this rate of money creation they will need more than helicopters to drop money. They may have to enlist the services of Goodyear blimps.
We Still Haven't Learned
This is truly monetary expansion of a biblical nature. Once again there is nothing to compare it with other than the monetary bubbles of the 17th century. Are we about to embark on an era of permanent government created prosperity or is this grand experiment in money creation (inflation) going to end the same way it has always ended throughout all of recorded history? That would be monetary chaos.
Historians would acknowledge the truth of the axiom that inflation has and will always be a monetary phenomenon. In his book ‘The Great Wave, Price Revolutions and the Rhythm of History” historian David Hackett Fisher wrote …”all great waves had important qualities in common. They all shared the same wave structure. They tended to have the same sequence of development, the same pattern of price-relatives, similar movements in wages, rent, interest-rates; and the same dangerous volatility in later stages. All the major price revolutions in modern history began in periods of prosperity. Each ended in shattering world-crises and were followed by periods of recovery and comparative equilibrium.” [2]
Fisher warns readers and perhaps today’s central bankers of the follies of the past. Many of today’s choices will determine tomorrow’s outcome which are dependent on our recall of the past. Fisher warns that when making decisions, it would help if we could sharpen or recall the past and remember some very hard lessons of history. Monetary alchemy has never worked and it will never will. History has proven this conclusively. Today’s alchemists recite the Keynesian dictum that ‘in the long-run we are all dead.” As it turns out we are still living and suffering from our mistakes. Today’s policies of fiat money or money dropped from helicopters as the Fed likes to say it will unleash the Perfect Financial Storm, the clashing of two monetary storm fronts one deflationary and the other inflationary that will meld and become the perfect monetary storm. The two monetary storms are about to collide to become one. The monetary jet stream is leading these two storm fronts towards collision. There is no turning back and there is no way out. I hope to elucidate this supposition in a series of weekly installments over the next few months.
What I hope to put to the pen is what historians have recorded over many centuries is that the pattern of the rise and fall of prices has been a constant throughout all of history. In his book “The Great Wave,” Fisher highlights a series of conditions that lead and give way to price revolutions. They begin during periods of prosperity which leads to population growth. These patterns are as follows:
1) General economic prosperity
2) Rise in birth rate
3) Demand rises for life’s necessities
4) Demand exceeds supply
5) Prices rise
6) Not all prices increase at same time
7) Prices of energy, food, shelter and raw materials rise
8) Energy prices rise faster than any other commodity
9) The price of manufactured goods rises more slowly at a time of accelerating commodity prices
10) Monetary inflation accelerates
11) Large scale currency debasement
12) Massive size government budget deficits
13) Growing gaps between returns to labor and capital
14) Growing wealth inequality and widescale social unrest
15) War
The Vicious Cycle of Prosperity
In viewing the present sequences, it is not too hard to discern many of today’s same headlines. General prosperity has helped to produce higher birth rates in the emerging market countries. This has triggered a greater demand for basic necessities such as food, water and energy. Commodity prices are rising faster than the price of manufactured goods. This is because of manufacturing efficiencies and productivity and not as a result of deflation as it is so often mistakenly labeled. (I’ll have more to say about deflation and why it has been mischaracterized by economists and financial analysts alike later on in the weeks ahead.)
Demand for energy is rising along with its price at an accelerating rate. Food prices are escalating and wealth inequality is on the rise as a result of inflation. Those who have assets and can afford to protect themselves are seeing their wealth increase by investments in gold, silver, energy and other tangible assets. The poor and less fortunate or those without savings are unable to protect themselves by investing in tangible assets and as a consequence are living hand to mouth. They go deeper into debt each month in order to live, so social stresses are building here in the U.S., and overseas in Europe, the Middle East, and in Latin America. Another Gulf War has been fought and perhaps another like it lies in its wake. Government budget deficits are out of control here in the U.S., Europe, and in Japan and are rising faster than global GDP. The U.S. dollar and other major currencies are locked in a continuous cycle of debasement.
Commodity Prices Rising Steadily
Today’s headlines look more and more like the chapters taken out of a history book. It would appear that the more that we advance and the older the world, becomes the more it remains the same. Growing populations, rising commodity prices, soaring energy costs, government budget deficits, dropping money from helicopters and other forms of monetary debasement, a falling dollar, rising social tensions, crime and war could all be taken out of the pages of Fisher’s history of price revolutions that occurred during the Medieval Ages, the Sixteenth, Eighteenth, and Twentieth Century. But they aren’t. They are right out of today’s headlines.
Today the price of soybeans soared once more hitting a price of $907, up 2.66 percent. Wheat prices are also going up as are hog and cattle prices, copper, corn and oil. As in similar price revolutions of the past commodity prices, especially energy, are rising faster than the price of manufactured goods. As I wrote back in the spring of 2002 in “The Next Big Thing” the price of everything we need is going up. Prices have only accelerated since that article was written back in April of that year.
The analysts and all of the experts are talking about deflation, but from where I sit and what I see we are seeing inflation sprout up everywhere as the supply of money and credit seems to be endless. As along as central banks and their respective governments have the power to print an endless amount of money either through the financial system or by dropping it from helicopters, we will be experiencing inflation, or in the case of the U.S., perhaps hyperinflation. Inflation has and always will be a monetary phenomenon. As to where it’s symptoms of higher prices show up--be it rising stock prices, rising bond prices and accompanying negative interest rates, inflating real estate prices or rising commodity prices--inflation is here to stay as long as governments and central banks are able to print money. A rise in prices, whether it is a rise in financial or tangible assets, that results in an increase in the quantity of money has always been shown to be the sole responsibility of government.
Today’s Markets
Stock prices ended lower on Monday with markets losing ground for the fourth day. As of today the NASDAQ has given just about all of its gains for the year losing another 1.5% today as the index gave back 30.41 points. Shares of Intel led the decline as analysts downgrade the tech sector and investors bail out of their technology holdings. Another game of sector rotation is about to begin. Technology shares which had gained 47% last year are down half a percent this year, the second worst performing group within the S&P 500’s top 10 industry groups. Money is leaving techs and financials, small and mid cap stocks and moving into drugs, energy, gold, silver, and large industrials. There is big money flowing into the precious metals sector as the smart money believes gold is heading for $500 this year. It may not be apparent yet, but it is visible in the money flows going into the sector.
On the earnings front, profits are up, but investors are selling into those profits. Profits are expected to rise this year but not at the torrid pace of the last two quarters of 2003. Moreover earnings comparisons will get even harder as we head into the second half of the year. They will become even more difficult as we head into Q1 of next year. Everyone has been expecting a correction going into next month. It is just a question as to how big it turns out to be. Money is still flowing into the market, but Lowry’s reports buying power is weakening while selling pressure has increased.
Total volume reached 1.4 billion on the NYSE and 1.9 billion on the NASDAQ. Market breath was negative by 20-11 on the Big Board and by 23-9 on the NASDAQ.
Jim Puplava
[1] Asia, its reserves and the coming dollar crisis, FinanceAsia.com, May 21, 2003 by Richard Duncan
[2] The Great Wave by David Hackett Fisher, p. 9
© 2004 Jim Puplava
February 23, 2004
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