"Eyes Wide Shut"

 

As our economic ship continues to spring leaks, the goldilocks crowd still clings to the false belief that the Fed can easily keep us afloat with a few more rate cuts. This comfort has sustained many upbeat forecasts despite overwhelming evidence of an unfolding economic and monetary catastrophe of historic proportions.

On Monday we learned that Merrill Lynch, having just sold a $4.5 billion stake to the Singapore government, is again passing around the hat, this time wooing the Chinese and Saudi governments for badly needed funds. This of course follows similar moves by U.S. investment houses Citigroup, Morgan Stanley and Bear Stearns. These developments should be disconcerting on many levels, yet most seem unperturbed.

In the first place, the fact that troubled firms need to look abroad for cash provides startling evidence of the extent of the deterioration of America's economic might. The reason we need to seek capital from abroad is that we squander our own on consumption.

However, these foreign investments come at great cost; specifically preferred shares that place new foreign shareholders in senior positions to existing American shareholders and burden the latter with substantial dividend payments (11% for Citigroup and 9% for Morgan Stanley). Of course, large dividend payments to foreign shareholders will only worsen our nation's current account deficit, putting more downward pressure on the dollar and the American standard of living. Contrary to Wall Street's positive spin of foreigners "investing in America," such acquisitions really amount to foreigners buying up America, as our creditors take our assets in exchange for our debts.

On Wednesday we learned that the December ISM Manufacturing Index plunged to 47.7, its lowest level in nearly five years. The news sent the dollar swooning, gold and oil soaring, and pushed the Dow Jones to its largest point drop ever on the first trading day of a new year (in percentage terms the second largest drop since 1932). The report amounted to a stunning repudiation of the hope that the U.S. will export its way out of a coming recession. If manufacturing is at a five year low, how can exports be booming? After all, we can not export what we do not make -- unless of course we simply export used goods, which eventually we will be forced to do. However, selling used cars to the Chinese will not create many new jobs here; as all that need be done is load the vehicles on ships and wave goodbye. This is hardly the export boom Wall Street has championed as our economic savior, offsetting the negatives of housing, financials and the consumer.

Weakness in manufacturing was further confirmed today, with the release of a very weak December jobs report that revealed a loss of another 31,000 manufacturing jobs. Anemic job growth (over-all payrolls increased by only 18,000) coupled with an increase in the unemployment rate to 5% sent stocks and the dollar tumbling. The stagflation bell is ringing load and clear, if only Wall Street had enough sense to listen.

Additionally, despite Wall Street's vehement denials, evidence of run-away inflation continues to appear. The minutes of the Fed's December 11th meeting, which discounted the risks of inflation, conveniently validated this misconception. Wall Street of course denies the obvious that such forecasts merely reflect the Fed's campaign to dampen inflation expectations and not an honest assessment of actual inflation. Today on CNBC, Mark Zandi, the highly-respected chief economist of Moody's Economy.com, proclaimed that the falling dollar "has nothing to do with inflation". Since a weak dollar is the very essence of inflation, this asinine statement is on par with the "permanent plateau" comment uttered by Irving Fisher on the eve of the 1929 stock market crash.

Along those lines, Wall Street continues to buy into government propaganda designed to confuse the public about the true cause of inflation. They dismiss rising prices as resulting from economic growth and then minimize the impact by relying on bogus CPI statistics. This completely misses the point that legitimate economic growth causes prices to fall and not to rise. True economic growth comes from increased production, which lowers consumer prices by increasing supply, particularly for basic necessities such as food. The reality is that despite some genuine economic growth abroad, governments are creating so much inflation that food prices are raising anyway.

Finally, Wall Street takes solace in the fact that long-term interest rates on U.S. Treasuries apparently reflect a benign outlook for future inflation as well. However, today's high bond prices are more a function short-term bets being placed by leveraged speculators and central bank buying, not the rational expectations of long-term private investors. Rather than reflecting quiescent inflation, low long-term interest rates result from a bubble in the bond market. When it bursts, the true rate of inflation, as reflected in the relentless run up in gold prices, will finally be priced in.

In the meantime, with $100 oil, $850 gold, and beans in the teens, Wall Street still feels the Fed has the green light to keep cutting interest rates. Unfortunately on this point they are right. Rather than raising rates on its own terms and accepting the consequences, the Fed will instead wait for a true financial crisis to emerge, at which point it will be forced to raise rates on the much more draconian terms imposed by our foreign creditors.

For a more in depth analysis of the tenuous position of the Americana economy and U.S. dollar denominated investments, read my new book "Crash Proof: How to Profit from the Coming Economic Collapse."

 

 

"If the dollar loses value too quickly, it could wreak havoc on the economy and financial markets - driving up interest rates and inflation and slashing Americans' purchasing power" -Peter Schiff 

 

 

"People keep talking about a Fed bailouts as if there is no cost. All the Fed can do is create new dollars. What that does is diminish the value of all the dollars everybody already has. They try to socialize the losses among all the holders of dollars" -Peter Schiff

 

 

Jan. 2 -  The world economy has had several good years. Global growth has been strong, and the divide between the developing and developed world has narrowed, with India and China leading the way, experiencing GDP growth of 11.1% and 9.7% in 2006 and 11.5% and 8.9% in 2007, respectively. Even Africa has been doing well, with growth in excess of 5% in 2006 and 2007. But the good times may be ending. There have been worries for years about the global imbalances caused by America's huge overseas borrowing. America, in turn, said that the world should be thankful: by living beyond its means, it helped keep the global economy going, especially given high savings rates in Asia, which has accumulated hundreds of billions of dollars in reserves. But it was always recognised that America's growth under President Bush was not sustainable. Now the day of reckoning looms............

 

"The housing bubble has burst. Prices are going to collapse and sales are going to fall through the floor." -Peter Schiff 

 

 

"With the Federal Funds Rate cut, the Fed revealed that it has no interest in defending the dollar or containing inflation. This kind of irresponsibility is all gold needs to move higher from its current levels unless the Fed somehow finds its backbone within a year or two, then gold has a good chance to take out its inflation-adjusted high of nearly $2,000 per ounce within this decade." -Peter Schiff

 

"Dollar fear sparks rush to oil and gold" - Financial Times
 

"It's going to soon hit $90 and go north of $100 next year. We should see $150 to $200 oil in the next two to three years because of the drop in the dollar. Once Asian countries allow their currencies to appreciate, demand will explode there.'' -Peter Schiff