Last week the U.S. Congress did us all a favor. $Gold rose by about $40 due to their efforts. What did they do? Well, the U.S. Congress voted to risk another depression by including a "Buy American" clause in what is mistakenly referred to as an economic stimulus plan. That clause bars the purchase of imported iron and steel. If the U.S. Senate persists in the "Buy American" requirements, and also bars the purchase of manufactured goods, in the American Recovery and Reinvestment Act of 2008 that risk of a depression will rise further. If ultimately signed into law, the Obama Depression looks like a betting man's risk.
In 1930 the U.S. Congress passed the Smoot-Hawley Tariff Act. That legislation was the first round in a series of government actions around the world that were a near death blow to global trade. That ensuing "trade ware" put the "Great" in the Great Depression. Now, the same myopic views risks igniting the second depression, the Obama Depression. With legislation like this being put forward in the U.S., being labeled a Gold Bug will become a sign of intellect.
The "Buy America" provision in this legislation is clearly intended to reward certain sectors of the electorate for their support in the past election. It does nothing to stimulate economic growth. It is really just a "Buy the Vote" action. And note, Canadians will be especially punished by this act for failing to volunteer to renegotiate NAFTA with Obama during the election.
Should this legislation be passed, other countries may feel pressured, politically, to also restrict their buying to suppliers in their native country. A global trade war could be ignited that leaves no winners, and all as losers. The U.S. is particularly vulnerable to trade retaliation. Our first chart this week is really intended as a way of present a collection of information. For now, note the bar on the far right. That is the size of U.S. exports, more than $1.8 trillion. That business will all be at risk if the Obama Pork Plan is enacted with a "Buy America" provision.
The first two bars are related to the U.S. government deficit, correctly defined. Part of the U.S. government deficit is hidden in something creatively called the Unified Budget. This concept hides part of the deficit with the current Social Security System surplus. And note, that surplus does not exist anywhere as it is all invested in U.S. government IOUs.
The Obama deficit will come in about $2.3 trillion, give or take a few hundred billion. How that deficit will be financed is a major question, with some serious implications. Thus far the U.S. government has turned to gullible foreign investors. Official foreign institutions, largely central banks, have already provided $2.5 trillion of financing for the U.S. That third bar from the left in the graph is their purchases in the past year, almost a third of the deficit in that year.
Congress is about to tell those foreign governments that money provided by this law can not used to buy from their citizens. Congress is telling the Chinese that this money cannot be used to buy from Chinese factories. At the same time, the U.S. government will be asking China to finance the spending authorized by the American Recovery and Reinvestment Act. While not privy to what the Chinese government will say to that hypocrisy, cannot imagine it will all be positive.
For some time the U.S. has relied on gullible foreign investors to finance the government's deficit. As a consequence, the Federal Reserve has not had to monetize much of the U.S. government deficit, despite the size of that deficit. And it followed, therefore, that U.S. inflation was reported as modest. That situation may be on a road to change.
In the second chart is plotted the year-to-year change in U.S. government debt held by foreign central banks and the Federal Reserves. Foreign central banks, the red line, have been increasing their holdings of U.S. government debt over the entire period shown. Sometimes they did so at fairly dramatic rates. Federal Reserve, the blue line, did not need to buy that debt, and allowed its holdings to fall.
Now that situation is changing. The red line has a slight negative trend, meaning the rate of acquisition of U.S. debt by foreign institutions is slowing. At the same time, the blue line is developing a positive slope. That means Federal Reserve is now buying, or monetizing, U.S. government debt. The situation may change dramatically if the "Buy American" requirement angers foreign governments, causing them to buy less U.S. debt. Remember, the money they use to buy U.S. debt comes from trade.
Just as a trade war mentality developed in the 1930s, so could it today. In the current period, the U.S. could face both trade retaliation and a debt boycott. With the Federal Reserve already monetizing much of the U.S. capital markets any requirement to monetize Obama's $2.3 spending deficit could have significantly negative ramifications for the U.S. and global economies, and the U.S. dollar.
Niall Ferguson in The Ascent of Money (2008) wrote:
"Inflation is a monetary phenomenon, as Milton Freedman said. But hyperinflation is always and everywhere a political phenomenon, in the sense that it cannot occur without a fundamental malfunction of the country's political economy."
Legislation currently being considered by the U.S. Congress may put the U.S., and a part of the rest of the world, on a path to the Obama Depression. Inflation, leading to hyperinflation, may be an unintentional path out of that situation because of a malfunctioning U.S. political economy. As always, Gold is the only means of protecting wealth from that which our governments do to us. Many had hoped for change in the last U.S. election. But as the singer sang, "Be careful what you wish for, you may get it." You got it, not suffer or own Gold!
GOLD THOUGHTS come from Ned W. Schmidt,CFA,CEBS as part of a joyous mission to save investors from the financial abyss of paper assets. He is publisher of The Value View Gold Report, monthly, and Trading Thoughts, weekly. To receive these reports, go to http://home.att.net/~nwschmidt/Order_Gold_EMonthlyTT.html.