Market Moves Ahead Should be Good for Gold, Bad for the US Dollar
By John Williams, Shadowstats
In the ever-evolving landscape of finance, nothing feels conventional anymore. The economy, financial systems, and even politics are experiencing upheaval. The repercussions of the 2008 financial crisis linger, with unresolved challenges that were merely postponed through unprecedented interventions by the Federal Reserve and the government. As we move forward, the potential for renewed panic looms, coupled with an unavoidable decline in the value of the US dollar and rising inflation.
Recently, however, there has been a surge of misconceptions regarding the Federal Reserve’s quantitative easing policy, the severity of US fiscal deficits, and the prospect of economic recovery. Contrary to the optimistic forecasts circulating in mainstream financial media, the likelihood of a significant reduction in the Federal Reserve’s Treasury purchases in the short term is minimal. In fact, the Fed seems committed to maintaining, if not increasing, its accommodative stance in the upcoming year. The critical financial issues facing the US will likely garner renewed attention by September 2013.
Since the 2008 crisis, the underlying fragility of the US financial system has not been addressed. The economy has yet to recover fully and is showing new signs of deceleration. As awareness grows regarding these realities—compounded by potential political scandals reminiscent of Watergate—troubled times for the US dollar seem inevitable, with inflation pressures escalating and gold and silver prices rising significantly.
The Federal Reserve’s Core Mission: Safeguarding the Banking System
Despite its Congressional mandate to promote sustainable economic growth with subdued inflation, the Federal Reserve primarily focuses on ensuring the stability of the banking system. Chairman Ben Bernanke has candidly admitted that the Fed has limited ability to stimulate economic activity at this stage. Consequently, the prevailing economic weakness serves as a rationale for continued easing from the Fed.
The Fed’s measures since the 2008 crisis have focused on sustaining the stability of financial markets. With bank bailouts becoming unpopular, the Federal Reserve has increasingly relied on economic stagnation as justification for its liquidity measures.
In response to criticisms regarding excessive accommodation, the Fed has undertaken several rounds of communication meant to mitigate inflation concerns, which have fueled recent gold sell-offs. However, remarks made during the Federal Open Market Committee’s June meeting clearly indicate that quantitative easing will not be curtailed until there is substantial economic recovery—aligned with the Fed’s overly optimistic projections.
As stock markets reacted negatively to Bernanke’s remarks, he emphasized that weaker economic conditions would necessitate increased easing. The ongoing signs of a weakening economy and persistent banking troubles imply that the Federal Reserve will continue its easing policies.
Despite widespread belief that QE3 will conclude by mid-2014, indications of deepening economic decline are likely to become evident soon, potentially shifting this perception. The harsh reality remains that persistent solvency issues within the banking sector, alluded to by Bernanke, ensure that extraordinary easing will continue.
In the latest iteration of quantitative easing (QE3), the Fed has ramped up its purchases of US Treasury securities—reflective of concerns about the government’s ability to sell its debt. By early July 2013, the Fed’s net purchases accounted for 90.5% of the net issuance of gross federal debt, exacerbated by the current limits imposed by the debt ceiling.
To illustrate how extreme the situation has become, consider that in 2008, the St. Louis Fed’s measure of the monetary base was around $850 billion, with only $40 billion in bank reserves. Today, that figure has surged to approximately $3.2 trillion, consisting of over $2.0 trillion in bank reserves. Yet, this substantial increase has not translated into normal lending practices, primarily due to the vulnerability of banks’ balance sheets.
While the expanded monetary base hasn’t significantly affected the broader money supply, some correlation exists between the St. Louis Fed’s monetary base and annual M3 growth rates. In June 2013, growth estimates in M3 stood at a correlation of 58.1%, which illustrates the challenges facing the banking system. If monetary growth slows despite the Fed’s easing, it suggests increasing financial stress within the banking sector.
The underlying reality of the US economy is tenuous enough to jeopardize domestic banking stress tests. Under these conditions, the Fed will likely continue to provide necessary liquidity as political cover for its actions is derived from a softening economy.
Anticipating a Renewed Fiscal Crisis by Early September
As it currently stands, the US Treasury is engaged in daily accounting maneuvers to keep its borrowings within the confines of the debt ceiling. According to the July 3, 2013 Daily Treasury Statement, borrowings were just shy of $16,999.421 billion. It is estimated that these “games” will soon reach their limit, necessitating a debt ceiling increase by early September 2013.
The long-postponed budget-deficit disputes will likely resurface, echoing the fiscal crisis of July 2011, which nearly collapsed the dollar and led to a sovereign credit downgrade. Although temporary measures could postpone the fallout, the unresolved issues risk inciting a renewed crisis of global confidence in the US dollar, potentially leading to additional downgrades of the country’s sovereign credit rating.
The core issue lies in the US government’s chronic inability to cover its extensive obligations without resorting to money printing. The GAAP-compliant federal budget deficit for fiscal year 2012 was a staggering $6.6 trillion—significantly greater than the cash-based deficit of $1.1 trillion. This discrepancy largely stems from ongoing liabilities related to programs like Social Security and Medicare.
Such deficit levels are unmanageable. The government faces insurmountable challenges in raising taxes enough to bridge the substantial annual shortfall. Dire cutbacks or restructuring social programs seem politically impossible under current circumstances. It appears that the ongoing contentious political environment will result in little more than superficial adjustments and further illusions in upcoming fiscal confrontations.
Understanding The Illusion of Economic Recovery
According to official accounts, a deep recession began in December 2007 and supposedly ended in June 2009, with the economy recovering since then. However, other key economic indicators—including employment rates and housing starts—paint a contrasting picture. In truth, the supposed recovery has been riddled with stagnation, with recent downturns signaling new troubles.
Essentially, the widely touted recovery serves as a mirage, artificially inflated by underreported inflation rates in GDP calculations. Over the last 30 years, various methodological changes have resulted in understated inflation figures, which have been predominantly used in GDP reports. These adjustments have skewed the perceived strength of the economy by masking genuine economic struggles.
In reality, the adjusted GDP figures reveal an economy characterized by prolonged stagnation rather than recovery. Many large consumer-oriented companies report that their business experiences align more closely with this adjusted economic reality rather than the official numbers. Structural liquidity challenges facing consumers—who drive over 70% of GDP—are paramount, rendering it impossible for sustained growth in real consumption without genuine expansion in real income or access to credit.
The crisis in household income further dilutes claims of recovery. Monthly median household income continued to decline even as the economy was purportedly rebounding. Without improved consumer liquidity, any current positive economic statistics are likely fleeting. Ultimately, the structural weaknesses in the economy suggest a bleak outlook for both the US dollar and budget deficit projections as these realities become increasingly recognized in global markets.
Additional Influences on the US Dollar, Inflation, and Precious Metals
The previous sections highlight significant factors where shifts in market sentiment have reversed implications for the US dollar, while potentially bolstering inflation and precious metal prices. Market attitudes are expected to shift more dramatically as economic downturns intensify and fiscal crisis tactics run their course.
Emerging political scandals within the current administration may also pose risks to perceptions of political stability in the United States, further pressuring the dollar’s value. Recent media coverage suggests increasing public awareness of these issues, raising the possibility of significant negative impacts akin to those experienced during the Watergate era.
If a scandal similar to Watergate unfolds, it could severely undermine confidence in the US dollar. Historically, when political crises converge with financial turmoil, such as the Arab oil embargo, the unraveling can dominate currency trading, exacerbating dollar weakness.
As the US dollar faces increased selling pressure, rising oil prices can be anticipated, compounding inflationary effects driven by a weakened dollar and the government’s fiscal neglect. A tide of dollar dumping from domestic and international actors could ensue, endangering the dollar’s global reserve status and eroding confidence in US currency, potentially ushering in severe domestic inflation and the risk of hyperinflation. In such tumultuous times, gold and silver emerge as essential hedges against the erosion of purchasing power.
With precious metals historically serving as a refuge during economic turbulence, the current environment presents a ripe opportunity for significant returns in this sector. Despite pessimism surrounding mining stocks, savvy investors who can identify resilient companies poised to thrive despite prevailing hardships may stand to benefit greatly.
This scenario is not hypothetical—it has transpired before in the US economic landscape. Those interested can explore the historical precedents and contemporary indicators of impending market shifts through resources such as Downturn Millionaires: How to Make a Fortune in Beaten-Down Markets, which lays out strategies for maximizing profits when the market rebounds.
Sincerely,
John Williams
for Economic Prism
[Editor’s Note: Economist Walter J. “John” Williams publishes http://www.shadowstats.com. ShadowStats specializes in evaluating the credibility of government economic data while offering alternative assessments based on common experience, void of contemporary methodological biases in metrics like inflation, unemployment, and GDP. Other analyses include M3 money supply estimates, discontinued by the Fed in 2006. Articles on the government’s understated inflation and deficit realities, as well as insights on potential hyperinflation risks, can be found on ShadowStats’ homepage.]
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