Is the Medicine Worse Than the Illness?
I usually enjoy what James Grant, of the appropriately named Grant's Interest Rate Observer, has to say. I'm not sure why I like him, I guess that he calls 'em like he sees 'em and what he has to say usually just makes sense. Take this opinion piece that he wrote for today's Wall Street Journal for instance, Is the Medicine Worse Than the Illness? .
Its basic premise is that the more of something there is, the less it is worth. He applies this basic principle of economics to the U.S. dollar and the massive printing of money that the government is currently undertaking. Here are a few excellent quotes:
"...Barely nudging Mr. Madoff out of the top of the news was the Federal Reserve's announcement last Tuesday that it intends to debase its own paper money. The year just ending has been a time of confusion as much as it has been of loss. But here, at least, was the bright beam of clarity. Specifically, the Fed pledged to print dollars in unlimited volume and to trim its funds rate, if necessary, all the way to zero. Nor would it rest on its laurels even at an interest rate low enough to drive the creditor class back to work. It would, on the contrary, 'continue to consider ways of using its balance sheet to further support credit markets and economic activity.'"
"Wall Street that day did handsprings. Even government securities prices raced higher, as if, somehow, Treasury bonds were not denominated in the currency with which the Fed had announced its intention to paper the face of the earth...One market, only, registered a protest. The Fed's declaration of inflationary intent knocked the dollar for a loop against gold and foreign currencies. In many different languages and from many time zones came the question, 'Tell me, again, now that the dollar yields so little, why do we own it?'"
"If the Fed is going to create boatloads of depreciating, non-yielding dollar bills, who will absorb them? Who will finance the Obama administration's looming titanic fiscal deficits? Who will finance America's annual surplus of consumption over production (after 25 more or less continuous years, almost a national trait)? Inflation is a kind of governmentally sanctioned white-collar crime. Every crime needs a dupe. Now that the Fed has announced its plan to deceive, where will it find its victims?"
The argument that the rapid printing of money without anything backing it combined with an economic slowdown and nonexistent interest rates should weaken a country's currency just makes too much sense to me. The only argument that can be made for a strong U.S. dollar harkens back to one of my favorite sayings, "In the land of the blind, the one-eyed man is king." Perhaps everyone else is worse off than the United States is. Perhaps things are so bad in the U.K and EU that they will eventually have to cut interest rates to nearly zero like the Federal Reserve has, lessening the interest rate differential.
Clearly, the world is currently in a fierce fight with deflation. I suspect that the economic downturn will last much longer than many people think. 2009 is going to be an unbelievably painful year, yet as I have said in the past I personally believe that it will not come even close to the level of pain that was experienced during the Great Depression.
I still believe that massive inflation is coming, but that it will take much longer to arrive than many people currently think. People who are betting on oil and commodities today had better pick companies that have manageable debt levels and solid access to capital to weather this downturn (and for goodness sake stay away from those oil sands companies, they're going the way of those oil shale experiments of years ago). Eventually the economy will stabilize and we will have to pay the price for all of the projects that low commodities prices have forced to shut down. Make no mistake, that day will come...but it probably will not be as soon as many currently believe. I am increasingly leaning towards any meaningful commodities recovery not occurring until 2010, but who knows if the U.S. dollar implodes before then prices may unexpectedly take off like a rocket.
Anyhow, check out the article. It's a great read. Santa is bringing me a copy of Grant's new book, Mr. Market Miscalculates. If I ever find the time to read it, I'll let you all know what I think.