Something to Worry About

January 9, 2006 – As we begin this new year, there is a lot to ponder over and worry about.  High on this list is the imminent departure of Alan Greenspan from the Federal Reserve, and the appointment of Ben Bernanke as his replacement.

Barron’s last week quoted Stephanie Pomboy of MacroMavens (4 Columbus Circle, New York, NY 10019).  Her words are well worth considering:

“[Later this] month, one of the greatest love affairs of all time will come to an end. More storied than Heathcliff and Cathy, Fred and Ethel or even Homer and Marge has been the love between Wall Street and its Monetary Maestro…As investors prepare to be passed off to their new suitor, they do so with little palpable concern. Glancing across the financial landscape, one finds no pangs of longing, no latent separation anxiety…just an eerie calm…

Contrary to the conventional wisdom that Ben is simply “son-of-Greenspan,” the reality is bound to prove quite different. These two men have about as much in common as Clinton and Bush…Like Bill, Alan awoke each morning, gauged the direction of the wind and positioned himself accordingly. He let the markets guide him. He was, to borrow his own favorite word — flexible. Ben is…doctrinaire, having a clear vision of how things should be and the fervent desire to see it through. He is Bush.

Where Alan bowed in dutiful obeisance to the markets, Ben would presume to tell the markets what the true underlying inflation/growth attributes are, pushing and prodding the markets to fit into his preconceived box…[This] could prove a most jarring discovery for Wall Street…

What they’ve failed to notice, however, is that Ben defines inflation in strictly economic terms, possessing a conspicuous blind spot for asset inflation. Witness the abstruse “Global Saving Glut” thesis he concocted to explain what is a simple case of too much money chasing too few financial “goods.” In Ben’s world, skyrocketing asset prices are not inflation, at least not any kind of inflation the Fed need concern itself with.

Readers of these letters already know that I don’t think much of Bernanke.  I skewered him in Letter No. 373, comparing him to the hapless William Miller, who briefly served as Fed chairman during the Carter administration.  I concluded: “Bernanke and his comrades will impose capital controls to maintain their power over this country’s command economy…to keep people fleeing from the dollar.”  I then went on to advise that Bernanke’s appointment just hastens the need to flee the dollar now while you still can.  That’s still good advice, but it’s not the only reason to exit the dollar.

The accompanying chart gives everyone who holds dollars something to worry about.  There are four clear trends on the chart, with a new, fifth trend beginning to emerge.  It is this new trend that is worrying, but before I get to that, let’s look at the other four trends first.

This chart presents the annual growth rate for M3, which is a measure of the total quantity of the dollars in circulation. The annual growth rate is calculated monthly.

I use this chart as a roadmap.  It lays out in clear detail the macro-trend for the dollar, and once we know that, we can then adjust our investment strategy accordingly. 

For example, this chart shows we had double-digit inflation in the 1970’s because M3 was growing at double-digit rates.  When Paul Volcker was named Fed chairman in 1979 and given the mandate to save the dollar, he did so by raising interest rates until M3 growth rates started to decline, ushering in a period of disinflation.  Alan Greenspan continued Volcker’s policy from his appointment in August 1987 until September 1992, when we actually had deflation according to its classical definition – M3 was less than it was the year before.  The subsequent reflation engineered by Greenspan ignited the stock market bubble that peaked in 2000, and over the past few years we’ve had a flight from the dollar.  Even though M3 growth rates were declining, they were not declining fast enough.  The money supply was still growing too fast.  As a result, the dollar lost purchasing power compared to the other national currencies, i.e., its exchange rate was falling.  But look at what is happening now.

Even though Bernanke is not yet sitting in Greenspan’s chair, the Fed is already pursuing a reflationary policy.  That’s what Bernanke wants – he is an inflationist.  Note how M3 growth over the past few months has exploded, and more importantly, it has now broken out from the declining trend channel that confined it since the 2000 stock market peak.  I have therefore used the “Bernanke Inflation” label to describe what is coming in the years ahead – and it isn’t pretty.

Inflation is going to worsen.  The dollar is headed down.  No, not just down – the dollar is going to collapse just like every other fiat currency has eventually collapsed.

Instead of correcting the problem at its source by re-establishing sound money policies and returning the country to gold and silver money as required by Article I, sections 8 & 10 of the Constitution, the Fed under Bernanke will usher in capital controls. 

It’s impossible to predict the nature of these controls, and how they will be implemented.  Nevertheless, we know now what these controls will mean. They will prevent you from doing what you want with your money.  But these controls will not preserve the purchasing power of the dollar, which is going to be inflated away in the months immediately ahead.