Monday, November 13, 2006

More On Hot-Air Money

Another source of the money fueling the US bubbling-asset economy may be coming from outside the US. It could simply be the cumulative effect of the whole world's loose monetary policy.

Don't forget that: (1) Half of American Treasury debt is held in the hands of foreigners; (2) a third of that is held by the Japanese alone; and (3) using the Japanese example, Japan has been pumping yen full throttle into their economy for several years now. In fact, who hasn't, to some degree or another; but Japan is particularly egregious.

There is a dispute going on between the Bank of Japan and the Japanese Treasury Department. The Bank would like to continue raising rates and destroying all those excess yen, and the treasury doesn't want that to happen, even going so far as changing the statistics the Bank uses to calculate inflation, undermining the Bank's argument. [Changes were made in August 2006.]

Why isn't that money "benefiting" the Japanese economy? For two reasons. First, because push-the-string Keynesian economics doesn't work; and second because it's no surprise that the Japanese investor loves American debt. Who wouldn't under those circumstances? Hey, just think about it. They can borrow at next to nothing, and buy American Treasuries yielding 4.something. It's called the Japanese carry trade. And it's going on like there's no tomorrow.

But this game only works as long as the dollar holds its value next to the yen, and everything I've been saying recently points to a weaker dollar. So why do they continue?

It's all a question of timing. If America and the dollar can hold onto their "tallest dwarf" status in the mid-term and only allow a smooth slip instead of a sudden drop, maybe foreign investors can continue holding onto our assets with impunity "until things get better" (or at least until the foreign speculator can pull out his marbles and go home.) That's what they're saying to themselves. But keep in mind that this kind of Keynesian mob thinking led us up to 1980.

gold dollar price
[Thanks to kitco.com for the chart.]

Maybe central banks will come to their senses and begin to realize the value of holding some percentage of gold in their reserves. Maybe. But until the majority do, gold has been so undervalued for so long, and its role as barometer of the world's currencies so underestimated, that it must find a new level. Remember my old dictum: You can take gold out of the standard, but you can't take the standard out of gold.

I'm betting that level is up, at least in the mid-term, although long-mid-term it may ultimately settle around where it is now in the $500-600 range, barring a total dollar collapse (in which case the sky's the limit.) Until then, to what degree will the dollar-gold price fluctuate until its new equilibrium is found? That's anyone's guess.

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