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May 31, 2005

Greenspan's Inflation-Wedgie
by Alex Wallenwein

Is Fed Policy a Bathroom Joke?

Actions of US monetary authorities have been inviting comments that increasingly drift toward the unappetizing, of late.

If you don't know what that means, I don't blame you. In plain English: US monetary policy is rapidly turning into a bathroom joke.

Bill Gross has already commented about the US' recent "bare-bottom" fiscal and monetary policies. By making the now notorious "discernable upcreep" remark on inflation in its minutes of the May 3rd the FOMC meeting, the committee has now left itself wide open to further jokes of that sort.

You might also call it: "US Inflation-Garment Creeps Up on Greenspan" or "Inflation Gives Greenspan Wedgies." Even the financial press couldn't resist but zero in on that particular part of the May 3rd FOMC minutes. It's just too tasty of a morsel to pass over - if you'll excuse the rather revolting extension of this thought.

All in all, it's a fitting metaphor of where US monetary policy in general, and the dollar in particular, are headed.

Down the toilet.

Here is the actual quote and some additional ones that put the first one in context with that portion of the minutes:

"A discernable upcreep was apparent in survey measures of short- and, to a limited extent, long-term inflation expectations over recent months ... However, available indicators of wages and benefits had registered only modest growth, suggesting to many that some slack in labor markets persisted (blah, blah, blah) ... Along with energy prices, import and materials prices apparently had contributed to the recent uptick in inflation, and pressures on inflation stemming from these three sources were expected to lessen over coming quarters ... (blah, blah) ... On balance, measures of core inflation were thought likely to remain in check over the remainder of this year and next." (Yeah, right.)

Here's what was really going through their minds when they drafted this mumbo-jumbo:

"We know exactly what's going down, but we don't want to tell you because you'll just want to protect yourselves (i.e., stop spending and start saving for the extremely rainy day that's coming) and spoil the party for the rest of us up here at the levers of power. After all, we've got our careers and legacies to worry about, don't you see? So, just eat our dust and shut up already."

Another point: Reading this statement makes me think that either Uncle Al has taught all of the other FOMC members, including the record keeper, to speak Greenspanese, or he literally dictated these minutes, which means they are not really minutes at all, but rather his own statement reflecting what he deems is "safe" for the investing public to know. My guess: it was probably the latter.

What was the press' reaction? Predictable confusion. One camp said it's a "dovish" statement because it means the current string of only moderate increases has no chance of getting cranked up. The other camp says it's "hawkish" because it means Greenspan definitely won't quit raising rates anytime soon. The overall effect was exactly what the Fed desired: on balance a wash. Or rather, a "wishy-wash," to be precise.

Greenspan and his cronies are deathly afraid that Joe Blow Investor figures out what they already know: That stuff will cost more in the future. A lot more. Greenie's congressional mandate to conduct monetary policy has devolved by necessity into a license to conduct public policy - meaning the prevention of a market-panic.

The bad-news part of this is that the old inflation-dragon is creeping up on him, sort of from behind and somewhat from below, to exert friction exactly where it's the most discomforting.

The good-news part is that the this statement's tortuous effort at giving something to everyone without upsetting anything (especially not the Fed's apple cart) raises exactly the question that so many free-marketeers have been saying for so long:

Who the hell needs a Fed?

If that is all they can come up with, who needs that?

The Fed's Real Job

It' like saying: "Well, the weather is very nice - except for that deadly, tornado-spawning thunderstorm rolling in from he West, so on balance, it's just a normal, boring day for you to go about your regular business."

What would you do to a weather forecaster who gives a report like this? You'd toss him out on the street. His job is decidedly not to avoid a panic. It's to warn you of any storms that might be brewing.

But then again, that's not really a fair comparison. Not fair to weather forecasters, anyway. They have no say in what the weather will do. They can't be blamed for it. But FOMC members can very much be blamed for what happens to the economy. They've been granted a legislative license to make "economic weather", if you will. When things go wrong, the proverbial egg is all over their faces.

And that means they have an institutional bias to lie, conceal, and obfuscate. But then again, we are the ones who allowed Congress to put and keep them there so, ultimately the egg is on our face.

Anyway, let's turn to what will likely be the effect of these minutes on the gold price going forward.

To What Effect?

The minutes didn't give the dollar-bulls what they wanted. They also didn't give the dollar-bears what they wanted. It did make each side feel better that the other side didn't get what they wanted, though.

So, does that mean the effect is nil?

No. Although I wouldn't call it "hawkish", the statement at the very least confirms that further 'measured' rate hikes are in the pipeline, and that is at least somewhat dollar-supportive.

But the negative effect of higher borrowing costs for businesses cannot be discounted. And, somebody out there in this irrational world of ours is apparently paying attention - because with very few exceptions, every time the dollar has a sustained rise, lately, the Dow goes on a diving expedition.

Economic Strength?

There's a lot of talk of recent US economic "strength", but all that talk conveniently leaves out the fact that all of that supposed "strength" is (a) highly relative, and (b) resting entirely on an already over-spent, under-saved US consumer - and on Asia's willingness to fund our trade/current account deficits..

It's relative because all the world's other economies outside of Asia suck even worse than that of the US, so it's nothing to brag about, really.

And the fact that the vastly overstretched US consumer has to perform the work of Atlas carrying the world on his shoulders isn't very reassuring, either. His savings are in stocks and bonds or are tied up in pension funds. These pension funds, of course, can only stay solvent via a multi-decade boom in US stocks (which Bush is trying to engineer via his social security "reform") - or if the money the gov't will need to pay out in the future is either borrowed or flat-out printed on demand.

Recognizing that, the Fed has figured that doing either printing or borrowing alone would be too obvious to us plebs, so they craftily figured out that they can pretend to borrow and then pretend to pay for it.

How does that work?

Easy.

Pretending to Borrow

They pretend to borrow by issuing US government debt (treasury bonds and notes) which nobody actually buys but they themselves - with freshly printed money. That's called "monetizing the debt." Conveniently, the Asians in the past have done a lot of treasuries-buying, so the Fed/Treasury gang were able to pass off their own buying of bonds as "demand" from Asia.

Recent proof, from the Department of the Treasury itself, though, has revealed that China has stopped buying altogether, and Japan has been selling treasuries for the last year - in exact opposition to what the press has been telling us. And what South Korea and the other Asians bought isn't worth shaking a stick at.

So, all in all, USD economic "strength" is a euphemism at best and a horrible joke on US consumers at worst. It is a Fed-engineered bail-out project in the truest sense.

So, who got bailed out?

Not the public - but the Fed bankers and US politicians. Everybody here in the lower ranks still thinks they've done a fine job.

And who's doing the bailing?

The US consumer, of course. The pails he uses to do his bail-out job are his own prodigious borrowing needs. He needs to finance his abundant lifestyle through more and more debt. He'll borrow himself all the way to Hell, just because it makes him feel richer

The Fed makes sure the debt-torrent keeps a-flowin' by engineering long rates further and further down (through clandestine debt purchases via the above-sited Caribbean "entities").

Pretending to Pay

The Fed, of course, never really pays for anything. It just prints money on demand or causes banks to issue it by lowering interest rates to encourage borrowing by the public.

The borrowed funds (mere "credit" entries on an electronic ledger that came out of nowhere) are then counted as part of the official money supply. In this case, the money the Fed uses to buy US treasuries comes fresh off the oft-quoted electronic printing presses. Since the money they print is itself only pretend money, the can do no more than pretend to "pay" for the bonds they "buy." Greenspan himself has acknowledged only a few years ago that gold is still the ultimate (and therefore the only real) form of payment.

The Effect on Gold

The FOMC minutes' effect on gold will be overall mildly supportive - just because it is so darn cryptic and confusing. Not that everything Greenspan puts his stamp on isn't cryptic and confusing already, but this one takes the cake.

The statement has already caused a lot of head scratching. A lot of analysts out there are developing a distinctive bald spot on their heads from all that scratching and are starting to look like Greenspan himself. (Darn! Does that guy have to clone himself everywhere?)

It is often said that the markets don't like uncertainty. These days, there is little else BUT uncertainty. The problem lies in recognizing that fact, and the recent FOMC minutes make a great case that the Fed guys are as dumbfounded as the rest of us are.

The only certainty that remains is that higher rates are bad for business and therefore bad for the Dow, and before long will do the Dow in. Businesses can't afford to satisfy their borrowing needs in the artificially suppressed long term markets, where consumers revel. They need short term cash.

If the Fed backs off, on the other hand, and stops or merely pauses in raising rates, the dollar will resume its diving mission with a vengeance. Don't even talk about what will happen to the dollar if the Fed starts dropping rates again.

Both cases are good for gold, since they are bad for the dollar - and either one of them will be "the case." And besides, gold is no longer a total slave to the dollar's fortunes, anyway. The days when gold stays flat or even rises on dollar-up days are increasing as time goes on. This is even more so with gold stocks.

The only problem is that either case is going to play itself out in the medium term. Short term, all bets are off, though I would favor a near-term pro-dollar trend, especially since the EU's would-be "constitution" was rejected by France yesterday and EU economies continue to suck air.

Just don't lose sight of the dollar-Dow relationship. It puts a very low ceiling over the dollar's sadly battered head - and therefore a nice cushion under gold's behind.

Got gold?

Alex Wallenwein
Editor, Publisher
The Euro vs Dollar Monitor

Just like driving your car, investing only makes sense if you can see where you are going. The Euro vs Dollar Monitor is your golden windshield wiper that removes the media's greasy film of financial misinformation from your investment outlook. Don't drive your investment vehicle without it!

Copyright © 2003-2008 Alex Wallenwein

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