A pseudonymous reply to GATA at MineWeb

Section:

Why gold is gaining in
a world awash with dollars

By Ian Lamont
The Scotsman, Edinburgh
January 13, 2003
http://www.business.scotsman.com/economy.cfm?id=43182003

The largest collection of warplanes ever
assembled is airborne. Their bomb bays are
burgeoning. Each flight is approaching its
target for a co-ordinated strike. Their
targets are not Baghdad or Basra, but the
major metropolitan areas of the United
States.

But wait. These are US air force planes. So
why are they flying a mission that has US
cities and citizens as targets?

Have scientists working for Saddam Hussein
developed a drug and rendered America's air
force insane? Or has George Dubya finally
flipped and ordered the extermination of all
potential Democratic presidential candidates
and voters?

Inspection of the bomb bays shows they are
not filled with conventional weapons or
weapons of mass destruction: No, the planes
are crammed with bundles of greyish-green
paper carrying the portrait of a dead
president on one side and the words "In God
We Trust" on the obverse. These are dollar
bills.

Why, you may well ask, is the US being
threatened with a massive bombardment with
its own currency? Is it a Marxist plot? Karl
Marx said that the way to overthrow
capitalism was first to destroy its money.

On the contrary, these planes are in the sky
24/7 on "Deflation Watch" and their purpose
is to save American capitalism.

A terrible fear-provoking thought is gaining
ground among the guardians of the US economy.
It is that the man in the street, who for
decades has enabled the economy to remain on
a long, upward path by consuming more than he
produces, may be reaching the limit of his
capacity for excess consumption and its
corollary debt.

Now, horror of horrors, the ever-rapacious US
consumers may be about to abandon profligacy
and restore their balance sheets by consuming
less and, perish the thought, saving.

In a pre-emptive campaign to prevent the US
consumer from abandoning over-spending and
embarking on a path of prudent parsimony,
Alan Greenspan has already used up most of
his conventional firepower and slashed the
Federal Funds rate to 1.25 per cent.

The US consumer, like the proverbial horse,
has been brought to water but is reluctant to
drink more. There is not yet panic within the
hallowed halls of the Fed but the spectre of
deflation, last seen in the 1930s, is
starting to loom larger and it is recognised
that unconventional weapons may be needed to
prevent it taking grip.

Dubya has already announced an economic
stimulus (anti-deflation) tax-cutting
initiative. There is a serious misconception
that central banks can increase or decrease
the money supply at will. The media make much
of central banks resorting to the "printing
press" to get economies out of trouble (or to
get them into trouble by over-cranking the
press and causing inflation).

In truth, the monetary system only works when
there are willing borrowers and willing
lenders.

In an attempt to boost money supply, the Fed
may aggressively buy Treasury Bonds from the
banks, thus forcing down long-term interest
rates and leaving the banks with vast sums of
cash to do with what they will.

But, if banks customers do not wish to borrow
then this "cranking of the printing presses"
by the Fed may have no impact on economic
activity. Remember, this is the first time
since the 1930s that the US has slumped
because the cost of capital during the
"bubble" was so low as to trigger excess
investment.

Thus, cutting the cost of capital (interest
rates) is unlikely to bring about a recovery
in investment. Only a sustained resurgence of
demand will, and if the consumer has also
"over-spent" in the bubble, and now needs to
reduce indebtedness, low interest rates will
have a minimal impact on demand.

The European Central Bank, obsessed with
monetary stability, seems determined to
plunge Euroland into depression. Nothing
could be more inappropriate than the current
proposals to raise taxes and cut public
spending in Germany and France to reduce
budget deficits and comply with the totally
ridiculous fiscal Stability Pact.

The Fed, by contrast, is prepared to think
outside the box. Ben Bernanke, a recent
arrival at the Fed from the academic groves
of Princeton, has declared that the Fed will
do all within its not inconsiderable powers
to "print" its way out of trouble before
deflation becomes entrenched.

We should not underestimate the efforts that
will be made to prevent deflation. With the
US trade deficit nearing 6 per cent of GDP,
the US is already pumping out so many
billions of dollars that it needs to attract
about 80 per cent of all the world's savings
just to maintain the value of the dollar.

With US interest rates already lower than
those in Europe, and US share valuations
still close to historic bull market highs,
attracting capital flows into the States is
becoming mighty onerous, further pump priming
will only add to the difficulty.

The dollar has been able to remain
fundamentally and seriously overvalued for
years because the rest of the world was
gullible enough to believe that the US
economy would always outperform and thus its
bonds and shares deserved a premium rating.
Some 75 per cent of central bank reserves,
plus a great deal of non-US private wealth,
is held in US dollar assets.

Now that the Fed has declared it will "print"
as many dollars as it takes to combat
deflation, holders of US dollar assets would
have to be extraordinarily nave not to
realise that an unlimited increase in the
supply of US dollars means dollars will
inevitably be worth less.

Thus, far from attracting the 80 per cent of
world savings required to maintain the
dollar's value, fear of the bomb bays being
opened and the world being showered in paper
dollars is likely to cause liquidation of
dollar investments.

In a deflationary world every country thinks
its currency overvalued and, although the
demise of fixed exchange rates has removed
"beggar-thy-neighbour" competitive
devaluations, if countries resort to the
printing press to try to avert deflation, all
their currencies become debased.

There is one standard against which this
debasement of currencies can be measured and
one asset which investors can own to protect
themselves: That standard and that asset is
gold.

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Ian Lamont is an Edinburgh-based commentator
and former stockbroker.