Disturbing Trend #5
The Alarming Growth of Foreign-held Debt
Foreign debt hangs like a sword of Damocles over the American economy. As our table illustrates this disturbing trend has shown the highest growth rate of them all. At this writing, foreign governments, institutions and individuals hold a collectively over $2 trillion of U.S. paper -- roughly one fourth of the national debt. Japan alone holds over $600 billion and mainland China over $400 billion. To suggest a measuring stick, federal tax receipts stand at roughly $2.2 trillion.
It is not just the presence of the debt itself which worries the inner sanctums of Wall Street, but the threat foreign-held debt represents to the U.S. Federal Reserve. Through the purchase and sale of U.S. Treasuries, foreign creditors can force interest rates up when the Fed would like to keep them down and force them down when the Fed would like to keep them up. In other words, the Fed very well may be losing control of interest rate policy. Recently, when the Congress threatened trade sanctions against China, the bond market began declining, thus pushing up interest rates. This foreign influence on Fed policy-making did not exist even five years ago.
There is an even darker aspect to the problem of foreign held debt, and that has to do with the international reaction to the future value of the dollar. If faith is lost, or even weakened to the extent that the trend to diversify out of dollars gathers steam, what is now a trickle of returning U.S. dollars could become a torrent. This, in turn, could trigger an uncontrollable inflation and dollar crisis globally.
Some analysts have pointed out that such an exodus would be farfetched in that the holders themselves would have a great deal to lose by unloading a large portion of their positions. The fact of the matter, though, is that the exodus has already begun. For example, Russia recently announced that it was juggling its reserves to purchase Japanese yen. Several Gulf oil producing states have quietly followed suit and are switching out of dollars and into both the euro and yen. Japan over the past year has actually reduced its Treasury position and Chinese officials recently suggested that its central bank might exchange some of its more than $1 trillion in reserves for gold and oil. Many nation states with large dollar holdings have formed sovereign wealth funds, the purpose of which is to utilize reserves to acquire other assets including hard commodities, natural resource companies and an array of other assets. Analysts often infer that their exodus will be controlled, but the problem with systemic crisis is that the evolution from a controlled liquidation to panic, particularly a panic in the ranks of private institutional funds, can come quickly and without warning. That said, even a slow-motion unraveling, or a simple withdrawal from regular U.S. debt purchases, could have a devastating effect on the value of the dollar.
Disturbing Trend #6
The Long-Term Decline of the U.S. Dollar
Would you own a stock that performed like the item represented in the graph below? The dollar is now a currency under siege. The cumulative effect of the disturbing trends outlined here has been to undermine the purchasing power of the dollar. In reality, it has been steadily debased in fits and starts since the Federal Reserve was created in 1913. However, in recent years that steady debasement has taken on a more urgent character due to the combined threats of a shrinking market for U.S. Treasuries and the dollar as the chief reserve currency. Add the current problems in the mortgage markets, which have pushed several major banks against the ropes, and you have the potential for an imminent dollar crisis. We may no longer have to gaze into the distant future for a glimpse of what is to come for the dollar. The day of reckoning might very well have already arrived.
The 1913 dollar is now worth less than 5 ¢ in purchasing power. The 1945 dollar is now worth less than 10 ¢. The 1970 dollar is now worth 19.5 ¢. The 1985 dollar (during a time when we were told repeatedly inflation was benign) is now worth only 58 ¢. This disturbing trend is troublesome to say the least, but when you consider that the depreciation of a currency, when it comes to inflation, is technically infinite (in other words there really is no bottom), you begin to understand why some have begun to view gold as a permanent aspect to the contemporary portfolio.
To show you how far we've come in so short a time, consider this statement in November, 2002 from Federal Reserve governor Benjamin Bernanke when asked about the tanking U.S. economy and fears of a deflation were running high: "The US government has a technology called a printing press -- or, today, its electronic equivalent -- that allows (the Federal Reserve) to produce as many US dollars as it wishes at essentially no cost." How many of us would have ever imagined a statement like that being uttered by a member of the Federal Reserve? And now that same Benjamin Bernanke has been appointed chairman of the Federal Reserve.
Managing the gold component of your portfolio
"I still sleep better at night knowing that I hold some gold. If or when everything else falls apart, gold will still be unquestioned wealth. I understand Warren Buffett's Berkshire Hathaway is sitting with $46 billion in cash, which I'm guessing is in US T-bills. But I wonder if Warren himself doesn't have a little box hidden away somewhere in Omaha, and that little box is filled with American gold Eagle coins. Warren's father was a big believer in gold, and some of daddy's philosophy probably rubbed off on Buffett."
- Richard Russell, Dow Theory Letters
At the risk of being judged overly simplistic, let me say that there are three potential outcomes to these disturbing trends:
First, things could improve, or, in a sudden fit of political and economic sanity, stabilize on a course that would lead to a complete recovery.
Second, they could stay the same. In other words, what we've had is what we are going to get.
Third, they could get worse. The long predicted collapse could actually occur.
If you believe that the first outcome is the most likely, you can stop reading here. You have no need to make any fundamental adjustments in your portfolio. If you are concerned, however, that either the second or third outcomes are most likely, then you will need to make some portfolio adjustments (if you haven't already), and those should center around the acquisition of gold.
One of the more interesting statistics in the accompanying table is the one that shows the stock market and gold turning in nearly identical performances over the thirty-seven year period covered by the study. This statistic might surprise many investors, including gold owners, given the amount of time the mainstream media spends dissing gold ownership, however, the numbers do not lie. What's more, cycle theory tells us that we are in the beginning years of the up-cycle for gold and the down-cycle for paper assets. The economic cycle favored tangibles - real estate, commodities and gold - from 1970 to 1985, and then turned in favor of paper assets in stocks and bonds. In 2002 the bear market for paper assets began as did the bull market for tangibles. If the duration of the past cycles holds true, the cycle top for hard assets should arrive sometime around 2017-2020. The point of taking you through this exercise is to show that gold looks to be about a third of the way through its bull cycle, while paper-based assets look to be about a third of the way in their long term bear market. The problems now present in the stock, bond and derivative markets are symptomatic of that larger trend.
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