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Published November 21, 2009  |
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That '70s show
The '70s are a warning that if Bernanke and the Obama administration's economic team continue with their excessive monetary expansion policy and US dollar neglect, the consequences could be severe.
By NEIL BEHRMANN
PERSISTENT US dollar weakness and the rush into gold seems to suggest that a growing number of investors and central bank treasurers believe that the United States is heading for the economic rocks of the 1970s. Those were the years of rampant inflation, high and rising unemployment and the coining of the word 'stagflation'.
Before examining whether the gold bulls and US dollar pessimists are correct in their analysis, let's examine the history of an economic decade which saw the 'misery index' rise with high inflation and growing queues of the jobless. The 1970s are an historic warning that if the US Federal Reserve Board chairman Ben Bernanke and the Obama administration's economic team continue with their excessive monetary expansion policy and US dollar neglect, the consequences could be severe. Foreign demand for US Treasury bonds will falter, leading to a sharp rise in market rates, a slide in the stock market, renewed economic decline and even higher unemployment. History, of course, doesn't repeat itself in exactly the same way, but there are numerous similarities between the 1970s and now. America was caught in the quagmire of the Vietnam War in the late 1960s when the stock market peaked and then crashed.
During the bear market bottom of 1970 some economic pessimists were predicting a repeat of the 1930s deflationary depression, similarly to the Cassandras of a year ago. Arthur Burns, chairman of the Federal Reserve Board decided to boost the money supply and lower interest rates and president Richard Nixon began the process of US dollar devaluation by bringing in the era of floating exchange rates in 1971. The US and the world experienced accelerating inflation and an asset bubble that led to surging share, gold, commodity and property prices. Unemployment fell during those heady times but that trend did not last for long. The 1973 Yom Kippur War between Israel and Egypt brought in its wake the newfound power of the Organization of the Petroleum Exporting Countries (Opec) which raised the price of oil from US$2.70 a barrel to US$13 in 1974. That move caused a crash on global stock, real estate and commodity markets and gold tumbled, while the US dollar rose. Once again the easy money and currency devaluation drug was applied and the stock market recovered. Inflation accelerated and unemployment continued to grow. Nixon left the scene in disgrace and in 1976, president Jimmy Carter replaced Arthur Burns with an even worse Fed governor, the genial Bill Miller, a businessman. Miller opened the monetary spigots and it was not too long before inflation was running at 14 per cent, the greenback was heading south, gold was soaring, but unemployment remained high. The fall of the shah of Iran caused oil prices to soar to US$40 a barrel before president Carter appointed the best post Second World War Fed governor, notably Paul Volcker. He had to apply the nasty medicine of tight money and punitive interest rates, causing the US dollar to soar. Volcker's policies and tight control of the government budget lead to an awful recession in the early 1980s. That policy, however, laid the groundwork for low inflation growth over the next two decades. This was a poor environment for gold which, but for a few rallies, performed poorly. Now once again the US is retreating from a failed war, ie the Iraq invasion and is struggling in Afghanistan. Forgetful or ignorant of history, the vast majority of US economists, bankers, asset managers and businessmen, including Paul Krugman and Warren Buffett are heaping praise on Bernanke and the Obama administration economists. To them, quantitative easing, or in less euphemistic language printing more money, and Keynesian borrowing and pump priming have saved the US and the world from deep deflationary depression. Prof Krugman, like-minded economists and other cheerleaders of the Obama administration and Fed, contend that the chances of accelerating inflation are highly unlikely. For that view to be correct the demand for money from indebted companies and consumers would have to be exceedingly low and the current recovering economy would have to falter. The administration and Fed have already stated, however, that in such circumstances there would be more Keynesian stimulus and another monetary drug booster. The well-intentioned aim to get all Americans working cannot be faulted and the equity and corporate bond rally is boosting confidence and is helping stretched businesses raise cheaper finance. The downside is that the formula has failed before and could make matters worse in the future. Growing numbers of foreign investors disbelieve Bernanke and Treasury Secretary Tim Geithner when they claim that they favour a strong US dollar. Indeed US dollar bears and gold bulls and several level-headed economists such as Brendan Brown, London-based chief economist of Mitsubishi UFJ Securities International, think that Bernanke is the most disastrous Fed chairman since Arthur Burns and Bill Miller. The critics have little faith in Geithner who, as chairman of the Federal Reserve Bank of New York, was at the epicentre of the 2006 to 2008 bubble and subsequent crash. The latest fund manager survey of Merrill Lynch shows that the number of critics is growing. A quarter of managers are now overweight gold and other commodities because they distrust the US dollar and expect inflation. The consequences would be bad for the US, Europe, which is already suffering from an overvalued euro, and Asia which is experiencing capital inflows that could suddenly turn into outflows. btworld@sph.com.sg |
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