The U.S. financial markets have taken on a dual personality, delivering both hope and fear.
The HOPE, now dominating the U.S. headlines, is reflected in the surging stock market.
Like a Dr. Jekyll, the stock market is strong, benevolent, and supposedly rational. It reflects one of the most fantastic economic stimulus programs of any government in history, plus the promise of more to come.
Meanwhile …
The FEAR, still mostly lurking beneath the surface, is reverberating in the plunging dollar market.
Like Mr. Hyde, the dollar market is weak, malevolent, and supposedly irrational. It reflects the most horrific side effects of the government’s economic stimulus program, plus the inevitability of more of the same: the U.S. budget deficit, the U.S. trade deficit, and widespread, bipartisan complacency about both.
Can this duality continue? Can the stock market go still higher even while the dollar sinks still deeper into an abyss?
Yes.
This has happened before, and it can happen again. In 1987, for example, Dad and I watched in shock as the dollar was bludgeoned to new lows … and in awe as the stock market roared to new highs. We had expected neither.
For nearly six months, we were wrong about the Dow, expecting it to crash almost any day. And for six months, the Dow continued to make new highs.
Then, it finally happened: In October of 1987, we witnessed a stock market crash, which, by all measures was TWICE as bad as the Crash of 1929.
Today, I’ve been wrong about the stock market again. It’s going up – not down. And many of the key indexes are making new multi-year highs – not multi-year lows.
Indeed, the same force that has been driving up oil, gold, commodities, and foreign currencies now appears to also be driving up stocks: Inflation and the rush from paper money into assets.
In other words, right now, the stock market is actually benefiting from inflationary forces, and may continue to do so – for a while.
No, this is not a new bull market. Nor is it your signal to jump into stocks with both feet. Quite to the contrary, it just another bubble that, from the very outset, is doomed to bust.
The reason: The most powerful nations on earth are unable to stop a 1987-style dollar crash. Let’s go back a few months, and you’ll see what I mean …
The Powerful But Powerless
The time is February of this year, a breezy and balmy weekend in South Florida.
The G-7 finance ministers meet at the Boca Raton Resort & Club, a short drive from my home in Palm Beach Gardens.
Nearby, golfers leisurely tee off at the par-72 Country Club Course, while windsurfers comfortably negotiate gusts and lulls offshore. Little do they realize that, inside, a drama is unfolding of historic dimensions: Probably the last chance for the ministers to somehow stabilize their currencies and stop the dollar from falling.
The economies represented are among the most powerful on the planet: The United States, Japan, Germany, France, Britain, Canada and Italy.
But the ministers at the meeting are virtually powerless. They have no influence over the exploding U.S. budget deficit. Nor can they do anything to stop the dizzying tailspin in America’s trade balance. All they can do is debate intensely and hope to come up with a joint statement – to signal some resolve and fortitude to international investors.
The statement will have to be both strong enough to be persuasive and, at the same time, weak enough to gain the unanimous support of the nations represented. But that turns out to be as easy as hitting a hole-in-one with a chopstick or tacking into a tsunami.
After three days of tireless deliberations, here’s what is announced to the world press anxiously waiting in the hallways:
“Excess volatility and disorderly
movements in exchange
rates are undesirable.”
The ministers line up and smile proudly before the cameras, hoping this placid non-statement will magically soothe the jittery financial markets. But it does not.
Thousands of miles to the north and east, in London, Paris, Frankfurt, and Tokyo, the dollar is pounded by wave after wave of selling, driven lower by the most powerful combination of fundamental forces ever amassed in one time and place:
Force #1. The lowest U.S. interest rates in history, making U.S. Treasuries and money markets far less attractive than their counterparts overseas.
Status today: Virtually no change. Although the Federal Reserve raised the fed funds rate to 2% last week, the large gap between U.S. and most foreign rates remains intact.
Force #2. The largest U.S. trade deficit in history.
Status today: Even larger.
Force #3. An out-of-control U.S. budget deficit.
Status today: Plans in the works to make it far worse.
So here we are, nine months later, and the dollar is getting pounded again. Indeed, since I wrote you last week, it has plunged still further and gold has hit $440 per ounce.
Nothing has changed. We remain, as before, on a collision course with a dollar decline of dramatic dimensions.
Complacency and Neglect
One of the key ingredients of a bubble is the consistent effort of those participating in the madness to discredit its detractors. For example, Lawrence Kudlow, CNBC’s economic commentator, writes this weekend that:
“Numerous pessimists … have also taken to gnashing their teeth over a softening dollar. For them, the glass is always half-empty. Conservative economists want the Fed and the Treasury to rescue the dollar. But this can only be done with a much more radical monetary tightening by the Fed, perhaps combined with a futile Treasury currency-market intervention policy. All this would be a mistake …
“First, the dollar is fundamentally undervalued at present. With the U.S. economic-recovery miracle continuing to build, and with the successful battle of Fallujah moving us closer to democratic elections in Iraq, the dollar is actually poised for a major rally. But perhaps only optimists can see this.
“For now, the real problem with the dollar is not so much that the Fed is too loose, but much more that the euro is way too tight. Just as with foreign policy, Old Europe has the monetary story wrong. New euros are being created at a way too stingy rate …”
In other words, Kudlow is arguing the dollar’s decline is overdone. Moreover, he figures it’s not the fault of America’s leaders for over-stimulating the U.S. economy – it’s the fault of Europe’s for under-stimulating theirs. His bottom line: Don’t change a thing. Let the dollar fall.
And this is precisely what our government is doing. They don’t seem to care that:
* Up to HALF of our nation’s budget deficit is being financed by foreign investors and central banks buying U.S. Treasuries. But when they lose more in our dollar than they can earn in our Treasuries, they’ll stop buying them, or worse, start SELLING … and our whole house of cards could come tumbling down.
* Without a strong dollar, it will ultimately be impossible to maintain a strong national defense.
* It will be increasingly difficult to finance on-going government operations – let alone our existing national debt.
* Our government and our Federal Reserve are not only neglecting THE dollar – they’re also attacking YOUR dollars: Every dollar in your pocket … in your checking account … your savings account … your stock and bond portfolios … and even in the equity in your home.
* Every time the dollar falls, it’s like someone broke into your bank and brokerage accounts and stole a few more of your dollars, then doctored your statements to hide their crime. Sure – your balances look the same. But the underlying power of your dollars – your purchasing power – is threatened.
Two Warnings
If no one was intensely concerned about the half-trillion-dollar budget deficits and the half-trillion-dollar trade deficits, it would indeed be alarming.
Fortunately, however, there are a few smart people who are watching this situation with growing alarm and, when the time is right, will be ready to help us get back on the right path. Listen carefully to their recent warnings:
The FIRST WARNING comes from David M. Walker, the Director of the U.S. Government Accountability Office (GAO) and Comptroller General of the United States. His words:
“Importantly, while [the U.S. government is] in a financial hole we don’t really have a very good picture of how deep it is.
“Specifically, there are a number of very significant items that are not currently included as liabilities in the federal government’s financial statements; for example, several trillion dollars in non-marketable government securities in so-called ‘Trust Funds.’
“In the case of the Social Security and Medicare Trust Funds, the federal government took in taxpayer money, spent it on other items and replaced it with an IOU. Given this fact, why aren’t the amounts attributed to such activities shown as a ‘liability’ of the U.S. Government? At the present time, they are not …
“The current U.S. government liability figures also do not adequately consider veterans’ health care benefit costs provided through the Department of Veteran’s Affairs, nor do they include the difference between future promised and funded benefits in connection with the Social Security and Medicare programs.
“These additional amounts total tens of trillions of dollars in discounted present value terms. Stated differently, they are likely to exceed $100,000 in additional burden for every man, woman, and child in America today, and these amounts are growing every day … The burden of paying for these is not a very nice present for a child born today …”
“The recent accountability failures in the private sector serve to reinforce the importance of proper accounting and reporting practices. It is critically important that such failures not be allowed to occur in the public sector …
“In this regard, earlier this year GAO was unable to express an opinion as to whether the U.S. Government’s consolidated financial statements were fairly stated for a sixth consecutive year. I can assure you that the U.S. Government will not receive an opinion on its financial statements from the GAO until it earns one …
“The bottom line is, there is little question that deficits do matter, especially if they are large, structural and recurring in nature. In addition, our projected budget deficits are not ‘manageable’ without significant changes in ‘status quo’ programs, policies, processes, and operations …
“In less than 10 years, due primarily to the retirement of the baby boom generation, the United States will be hit by a huge demographic tidal wave that is not expected to ever recede. This is unprecedented in the history of our nation …”
The SECOND WARNING comes from Robert E. Rubin, former secretary of the Treasury; Peter R. Orszag, senior fellow at Brookings Institution; and Allen Sinai, Chief Global Economist at Decision Economics, Inc. Their words:
“The U.S. federal budget is on an unsustainable path. In the absence of significant policy changes, federal government deficits are expected to total around $5 trillion over the next decade. Such deficits will cause U.S. government debt, relative to GDP, to rise significantly. …
“Substantial ongoing deficits may severely and adversely affect expectations and confidence, which in turn can generate a self-reinforcing negative cycle among the underlying fiscal deficit, financial markets, and the real economy:
” * As traders, investors, and creditors become increasingly concerned that the government would resort to high inflation to reduce the real value of government debt or that a fiscal deadlock with unpredictable consequences would arise, investor confidence may be severely undermined;
” * The fiscal and current account imbalances may also cause a loss of confidence among participants in foreign exchange markets and in international credit markets, as participants in those markets become alarmed not only by the ongoing budget deficits but also by related large current account deficits;
” * The loss of investor and creditor confidence, both at home and abroad, may cause investors and creditors to reallocate funds away from dollar-based investments, causing a depreciation of the exchange rate, and to demand sharply higher interest rates on U.S. government debt;
” * The increase of interest rates, depreciation of the exchange rate, and decline in confidence can reduce stock prices and household wealth, raise the costs of financing to do business, and reduce private-sector domestic spending;
” * The disruptions to financial markets may impede the intermediation between lenders and borrowers that is vital to modern economies, as long-maturity credit markets witness potentially substantial increases in interest rates and become relatively illiquid, and the reduction in asset prices adversely affects the balance sheets of banks and other financial intermediaries;
” * The inability of the federal government to restore fiscal balance may directly reduce business and consumer confidence, as the view of the ongoing deficits as a symbol of the nation’s inability to address its economic problems permeates society, and the reduction in confidence can discourage investment and real economic activity;
” * These various effects can feed on each other to create a mutually reinforcing cycle; for example, increased interest rates and diminished economic activity may further worsen the fiscal imbalance, which can then cause a further loss of confidence and potentially spark another round of negative feedback effects.
“Although it is impossible to know at what point market expectations about the nation’s large projected fiscal imbalance could trigger these types of dynamics, the harmful impacts on the economy, once these effects were in motion, would substantially magnify the costs associated with any given underlying budget deficit and depress economic activity much more than the conventional analysis would suggest …”
Contrary to Wall Street’s assertions, these are not just perennial pessimists whistling in the dark. These are well-researched, extremely precise forecasts – made late last year and earlier this year – that are ALREADY coming true.
Listen to them very carefully. Although the stock market’s euphoria could continue, do not let it distract you from the Mr. Hyde that lurks beneath the surface.
Good luck and God bless!
Martin
Martin D. Weiss, Ph.D.
Editor, Safe Money Report
Chairman, Weiss Ratings, Inc.
martinonmonday@weissinc.com
P.S. Important reminder: If you’re in Washington, D.C. area, please join me tomorrow (Tuesday, November 16th) from 6pm to 8pm at the Mansion on “O” Street. The occasion is the official re-launch of my father’s Sound Dollar Committee, a non-profit, non-partisan organization dedicated to fighting for an honest budget and a sound dollar. For directions, visit
http://www.omansion.com/contact/dirpopup.html
If you have already e-mailed back your RSVP, thank you! If not, please do so now to gsoles@mrss.com.
