The Coming Apocalypse
Ever since the invention of coinage, the sly tendency of those in charge of minting the coins has been to debase their value secretly, so that those in the know could purchase their desires before the worthless currency lands in the hands of the ignorant masses and loses its purchasing power as excess money chases scarce goods. The story of Muhammad Bin Tughlak forging leather coinage to replace silver and gold and the Weimar Republic printing paper marks till one needed a billion marks to buy a pack of cigarettes are ample proof of these tendencies. More recent episodes of hyperinflation and currency devaluation in Argentina, Brazil and Turkey recount their sorry tales. Argentina declared bankruptcy and Brazil is in a straitjacket. They have huge foreign debts denominated in dollars. Any rise in interest rates may make debts unserviceable. A minor rise in Australian interest rates is deflating its housing bubble and similar fates await housing in Ireland, UK and probably even the US.
America runs half a trillion dollar trade, current account and budget deficits each, and needs to borrow two billion dollars a day to support its profligate spending and lifestyle. Currently Asian countries provide this. They often end up as losers because they get low interest on their dollar holdings, which depreciate in value as the dollar sinks. Japan gets the nuclear umbrella and military protection for holding nearly a trillion dollars as reserves. Taiwan and South Korea hold nearly 200 billion dollars each and for that they get military protection. China holds nearly 500 billion dollars but protects itself by holding its own currency at a fixed exchange rate to the dollar and not permitting free movement of capital. It tolerates the disadvantage because it wants to provide employment to its teeming masses of unemployed and those being laid off from bankrupt state enterprises producing shoddy, useless and excess goods of no value. These are the reasons for the rise in price of gold, oil and other commodities. Additional reasons are increased consumption by China and India and the disasters in Iraq and Afghanistan. This is why the Euro has gone up against the dollar unlike manipulated currencies like the yen and Yuan.
To counter the collapsing bubble in stock prices in 2000 and because of abandonment of sane policies for political support of the Bush administration tax cuts, the Federal Reserve had opened the spigots of money supply. This re-inflated the stock market and produced a bubble in home prices. The Fed is already behind the curve and the inflation genie is out of the bottle. The Fed's job is to take away the punch bowl as soon as the party livens up and becomes rowdy (raise interest rates). Under ordinary circumstances it does that to preserve the purchasing power of the haves who are the lenders. William Greider's book 'Secrets of the Temple' explains it well. The problem this time is, America is the world's largest debtor and a good deal of its debt is owed to foreigners (nearly two trillion dollars of treasury securities). Japan has a larger debt to GDP ratio but its debt is owed to Japanese nationals. Furthermore the current administration's fiscal and military misadventures ensure large deficits in perpetuity. The low savings and high consumption rates of the American public perpetuate the need to borrow from abroad.
Rising interest rates would raise the interest cost of servicing our national debt. What makes it even worse, is the high home equity, adjustable mortgage and credit card debt of the American public. A rise in interest rates would put sharp brakes on consumer spending on which the bulk of our economy depends. It would put a damper on the feel good state of many a consumer feeling rich due to rapidly risen home prices. The rising interest rates would burst the housing bubble. Greenspan has irresponsibly encouraged new homeowners to take adjustable rate mortgages to be able to afford the payments on overpriced homes. This is why the Fed keeps repeatedly reassuring the markets that interest rate increases will be measured (meaning small) and gradual. This is also why the government changed the way it measures inflation so it can understate it and thus give smaller raise in social security payments and less adjustment upward to the face value of Treasury Inflation Protection Securities (TIPS). Credit card debts and medical bills of the uninsured are the predominant causes for the 1,500,000 persons who file for personal bankruptcy each year. Incidentally this number exceeds that of the annual college graduates.
To eliminate the trade deficit we need to have a long run of huge trade surpluses. This means consume less and export more. We have hollowed out our manufacturing so we cannot run a manufacturing surplus. Even our near monopoly in airplanes is being lost. This year Airbus may beat Boeing. This is why we are fighting so hard for TRIPS (intellectual property and financial services) at the WTO meetings in Doha, Cancun etc. To help us, our exports, grain and meat have to remain high priced, which will add to domestic inflation. Foreigners have reduced the purchase of American stocks and bonds and even the buying of American businesses. Even the flow of domestic money in American stock and bond funds is decelerating. The massive but inappropriate and misdirected Keynesian tax cut stimulus is over. If Bush is re-elected there will be no further tax cuts and reduction in social and entitlement spending. The accelerated investment tax credit for businesses has front-loaded business investment into the current year with a sharp reduction likely in the second half and next year. Year to year profit comparisons will look anemic from now on. If Kerry is elected the cancellation of future tax cuts will reduce discretionary corporate and rich peoples' income and thus savings and investment. The recovery with reduced job growth compared to prior recoveries is showing tachyphylaxis and further monetary stimuli have the same effect as flogging a dead horse.
To add fuel to the fire, no pun intended there is the political uncertainty in Saudi Arabia causing high oil prices. The mess in Iraq and Afghanistan coupled with the boiling cauldron of Pakistan and the belligerent nuclear arming North Korea and Iran bode ill. The more autocratic Russia after America's destruction of its economy by privatization, capitalism and criminal oligarchy manipulation and a bristling nationalistic re-arming China add greater uncertainty and adverse variables to the world economic equations. The political uncertainty of the American elections creates anxiety and the US markets sooner rather than later are headed down significantly, if not sharply.
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Gaurang Bhatt, MD
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