Week Ending 3/6/09
There is a correlation between the U.S. dollar and commodities, just as there is between many assets; however, correlation is not the same thing as causality.
Any two items may move in the same direction, but that does not mean that one caused the other to do so, or vice versa. That may be the case, but it is not a given. To assume otherwise would be ill-advised.
Such misassumptions are pure Keynesian voodoo-economics, allowing the mistaken belief that devaluing a currency can be a good thing. If a currency is devalued it means it is losing purchasing power.
If a currency is losing purchasing power, then money buys fewer goods per unit [dollar]. This means wealth is being lost, i.e. purchasing power. This is not a good thing. The debasement and destruction of a currency is never a good thing.
For instance: in 2002 the Fed lowered interest rates and the dollar fell. Did lowering rates cause the dollar to fall? Perhaps, perhaps not. It may be a contributing factor, but is it the only factor; or main factor?
Since 2008 the Fed has aggressively lowered interest rates, yet the dollar did not fall - it has been rising, while at the same time commodities have hardly budged and remain near their lows.
If falling interest rates caused the dollar to fall in 2002, while commodities rose - why isn't that happening now? Clearly, somethingis different.
Take gold as another example: the dollar and gold move inversely to one another. Does this mean that one causes the other to move? Why have both the dollar and gold been rising together since late 2008? Clearly, something is different.
Does gold move the dollar; or does the dollar move gold; or is there something else that moves both? Or perhaps neither is the case.
How do we explain the recent change of gold and the dollar moving in the same direction?
The euro and gold have moved in the same direction for years. Does that mean that the euro caused gold to go up; or that gold caused the euro to go up?
Could there be a third factor that makes both the euro and gold move? Since late 2008 the euro has gone down, yet gold has gone up. Something is different.
In last week's market wrap it was mentioned how various inter-market relationships have been acting different since late 2008.
This is especially true with certain currencies and gold, especially the dollar; as well as between gold and other asset classes. Last week's wrap stated:
"What happened was the financial crisis and investor's perceptions that gold is the safest asset existent. It retains purchasing power better than any of currency or asset.
There has been a flight to safety into gold. The U.S. dollar has experienced the same, but to a lesser degree.
For awhile, both the Yen and T-bonds were experiencing a flight to safety, but both have given up their recent strength."
What moves markets are investor's perceptions, be they correct or not. And what moves investors to buy or sell is greed and fear.
While it may be true that it will be difficult to inflate our way out of deflation while the dollar is rising, this does not mean that we will not inflate our way out; nor that the dollar will keep rising. We should be careful what we wish for, as it may come true - in spades.
Deflation is a monetary phenomenon characterized by a contraction in credit issuance. As Ludwig von Mises stated in The Theory of Money and Credit:
"Again, deflation (or restriction, or contraction) signifies a diminution of the quantity of money (in the broader sense), which is not offset by a corresponding diminution of the demand for money (in the broader sense), so that an increase in the objective exchange value of money must occur."
The only thing the Fed knows how to do is inflate. Bernanke is on record saying that the Fed has a printing press and will use it to print whatever amounts of money are needed. He has said he will drop the money from helicopters if need be.
The Fed's balance sheet is up well over 100% since the financial crisis began. It is obvious that the Fed will continue to open the money spigots until inflation overcomes the recent deflationary collapse of asset prices.
There is a lot of reflating required just to fill up the void caused by the boom now gone bust.
I'm not saying this is the correct course of action to take, as I do not believe it is; however, the Fed and the Treasury are working under that assumption.
Their modis operandi is to pour more fuel on the fire in a vain attempt to put it out. It will not work. It never has and never will.
Since the Fed was created in 1913 the dollar has lost 96% of its purchasing power - now that's devaluation.
This is what got us into this mess; along with FDR confiscating the people's gold and devaluing the currency as well, which was tantamount to declaring national bankruptcy.
In continuation of last week's theme as to why gold and the dollar have been moving up in tandem, I will offer another view from another source: the Bank for International Settlements (BIS): the central bank of the central bankers - the hub of the wheel if you will.
Murray Rothbard wrote a seminal paper titled: Economic Depressions: Their Cause and Cure by Murray N. Rothbard decades ago, yet it reads like it was written last week. Its analysis of past depressions describes to a tee what is going on today. The quote is long, but well worth the read.
"Without bank credit expansion, supply and demand tend to be equilibrated through the free price system, and no cumulative booms or busts can then develop. But then government through its central bank stimulates bank credit expansion by expanding central bank liabilities and therefore the cash reserves of all the nation's commercial banks. The banks then proceed to expand credit and hence the nation's money supply in the form of check deposits. As the Ricardians saw, this expansion of bank money drives up the prices of goods and hence causes inflation. But, Mises showed, it does something else, and something even more sinister. Bank credit expansion, by pouring new loan funds into the business world, artificially lowers the rate of interest in the economy below its free market level.
On the free and unhampered market, the interest rate is determined purely by the "time-preferences" of all the individuals that make up the market economy. For the essence of a loan is that a "present good" (money which can be used at present) is being exchanged for a "future good" (an IOU which can only be used at some point in the future). Since people always prefer money right now to the present prospect of getting the same amount of money some time in the future, the present good always commands a premium in the market over the future. This premium is the interest rate, and its height will vary according to the degree to which people prefer the present to the future, i.e., the degree of their time-preferences.
People's time-preferences also determine the extent to which people will save and invest, as compared to how much they will consume. If people's time-preferences should fall, i.e., if their degree of preference for present over future falls, then people will tend to consume less now and save and invest more; at the same time, and for the same reason, the rate of interest, the rate of time-discount, will also fall. Economic growth comes about largely as the result of falling rates of time-preference, which lead to an increase in the proportion of saving and investment to consumption, and also to a falling rate of interest.
But what happens when the rate of interest falls, not because of lower time-preferences and higher savings, but from government interference that promotes the expansion of bank credit? In other words, if the rate of interest falls artificially, due to intervention, rather than naturally, as a result of changes in the valuations and preferences of the consuming public?
What happens is trouble. For businessmen, seeing the rate of interest fall, react as they always would and must to such a change of market signals: They invest more in capital and producers' goods. Investments, particularly in lengthy and time-consuming projects, which previously looked unprofitable now seem profitable, because of the fall of the interest charge. In short, businessmen react as they would react if savings had genuinely increased: They expand their investment in durable equipment, in capital goods, in industrial raw material, in construction as compared to their direct production of consumer goods.
Businesses, in short, happily borrow the newly expanded bank money that is coming to them at cheaper rates; they use the money to invest in capital goods, and eventually this money gets paid out in higher rents to land, and higher wages to workers in the capital goods industries. The increased business demand bids up labor costs, but businesses think they can pay these higher costs because they have been fooled by the government-and-bank intervention in the loan market and its decisively important tampering with the interest-rate signal of the marketplace.
The problem comes as soon as the workers and landlords - largely the former, since most gross business income is paid out in wages - begin to spend the new bank money that they have received in the form of higher wages. For the time-preferences of the public have not really gotten lower; the public doesn't want to save more than it has. So the workers set about to consume most of their new income, in short to reestablish the old consumer/saving proportions. This means that they redirect the spending back to the consumer goods industries, and they don't save and invest enough to buy the newly-produced machines, capital equipment, industrial raw materials, etc. This all reveals itself as a sudden sharp and continuing depression in the producers' goods industries. Once the consumers reestablished their desired consumption/investment proportions, it is thus revealed that business had invested too much in capital goods and had underinvested in consumer goods. Business had been seduced by the governmental tampering and artificial lowering of the rate of interest, and acted as if more savings were available to invest than were really there. As soon as the new bank money filtered through the system and the consumers reestablished their old proportions, it became clear that there were not enough savings to buy all the producers' goods, and that business had misinvested the limited savings available. Business had overinvested in capital goods and underinvested in consumer products.
The inflationary boom thus leads to distortions of the pricing and production system. Prices of labor and raw materials in the capital goods industries had been bid up during the boom too high to be profitable once the consumers reassert their old consumption/investment preferences. The "depression" is then seen as the necessary and healthy phase by which the market economy sloughs off and liquidates the unsound, uneconomic investments of the boom, and reestablishes those proportions between consumption and investment that are truly desired by the consumers. The depression is the painful but necessary process by which the free market sloughs off the excesses and errors of the boom and reestablishes the market economy in its function of efficient service to the mass of consumers. Since prices of factors of production have been bid too high in the boom, this means that prices of labor and goods in these capital goods industries must be allowed to fall until proper market relations are resumed.
Since the workers receive the increased money in the form of higher wages fairly rapidly, how is it that booms can go on for years without having their unsound investments revealed, their errors due to tampering with market signals become evident, and the depression-adjustment process begins its work? The answer is that booms would be very short lived if the bank credit expansion and subsequent pushing of the rate of interest below the free market level were a one-shot affair. But the point is that the credit expansion is not one-shot; it proceeds on and on, never giving consumers the chance to reestablish their preferred proportions of consumption and saving, never allowing the rise in costs in the capital goods industries to catch up to the inflationary rise in prices. Like the repeated doping of a horse, the boom is kept on its way and ahead of its inevitable comeuppance, by repeated doses of the stimulant of bank credit. It is only when bank credit expansion must finally stop, either because the banks are getting into a shaky condition or because the public begins to balk at the continuing inflation, which retribution finally catches up with the boom. As soon as credit expansion stops, then the piper must be paid, and the inevitable readjustments liquidate the unsound over-investments of the boom, with the reassertion of a greater proportionate emphasis on consumers' goods production.
Thus, the Misesian theory of the business cycle accounts for all of our puzzles: The repeated and recurrent nature of the cycle, the massive cluster of entrepreneurial error, the far greater intensity of the boom and bust in the producers' goods industries.
Mises, then, pinpoints the blame for the cycle on inflationary bank credit expansion propelled by the intervention of government and its central bank. What does Mises say should be done, say by government, once the depression arrives? What is the governmental role in the cure of depression? In the first place, government must cease inflating as soon as possible. It is true that this will, inevitably, bring the inflationary boom abruptly to an end, and commence the inevitable recession or depression. But the longer the government waits for this, the worse the necessary readjustments will have to be. The sooner the depression-readjustment is gotten over with, the better. This means, also, that the government must never try to prop up unsound business situations; it must never bail out or lend money to business firms in trouble. Doing this will simply prolong the agony and convert a sharp and quick depression phase into a lingering and chronic disease. The government must never try to prop up wage rates or prices of producers' goods; doing so will prolong and delay indefinitely the completion of the depression-adjustment process; it will cause indefinite and prolonged depression and mass unemployment in the vital capital goods industries. The government must not try to inflate again, in order to get out of the depression. For even if this reinflation succeeds, it will only sow greater trouble later on. The government must do nothing to encourage consumption, and it must not increase its own expenditures, for this will further increase the social consumption/investment ratio. In fact, cutting the government budget will improve the ratio. What the economy needs is not more consumption spending but more saving, in order to validate some of the excessive investments of the boom.
Thus, what the government should do, according to the Misesian analysis of the depression, is absolutely nothing. It should, from the point of view of economic health and ending the depression as quickly as possible, maintain a strict hands off, "laissez-faire" policy. Anything it does will delay and obstruct the adjustment process of the market; the less it does, the more rapidly will the market adjustment process do its work, and sound economic recovery ensue.
The Misesian prescription is thus the exact opposite of the Keynesian: It is for the government to keep absolute hands off the economy and to confine itself to stopping its own inflation and to cutting its own budget."
Sound eerily familiar? - It should, it's presently occurring across the globe: one big boom that has now gone bust. Sir Alan's bubble has popped.
Gold was volatile once again, but when all was said and done it only gained .20 cents (continuous contract) for the week. Intra-day lows were near $900, while intra-day highs were around $960, so there was plenty of price movement.
Many believe the correction is over, and it may be, however, I wouldn't be surprised to see another test of the lows. Expect volatility and expect the unexpected.
The monthly chart shows MACD getting into position to make a positive crossover, which will be a bullish long term signal, if and when it occurs. A most interesting chart pattern appears to be forming.
The daily chart of GLD has mixed signals. The dominant chart feature is the gold cross of the 50/200 dma. This is a bullish signal.
MACD is still under a negative crossover, however, and volume has been shrinking on the rally. There are a couple of gaps that remain open.
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Good luck. Good trading. Good health, and that's a wrap.
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